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Four practical steps to financial sustainability in public pensions

Pensions transformation is possible when leaders take pragmatic steps to close the pension gap.

Overview

United States state pension plans are underfunded by an estimated $2.2 trillion, though reported estimates vary.1 And soon, these unfunded liabilities will be under greater scrutiny. Beginning in 2015, 100 percent of states will be required to show unfunded pension liabilities on their balance sheets.

Given the high stakes, it may seem a high mountain for public sector leaders in the US and Europe to climb to shape an affordable, balanced plan to get pension plans on a path to fiscal recovery. By taking pragmatic steps to solve the financial sustainability challenge, leaders can slowly—but surely—climb the mountain and get to firm financial footing. Beneath their feet, they will have spending on past generations, and arrayed before them will be the right paths to support future generations. From this clear vantage point they can take the right action to solve this important public policy issue.

1 Moody’s, “Adjustments to US State and Local Government Reported Pension Data,” July 2, 2012 – page 9.

Background

For pensions agencies facing the sustainability struggle, there is a cost of inaction. With a pension-funding ratio falling at least 21 percent over the past five years and a shortfall topping $100 million, Illinois’ debt was rated by credit agencies at the lowest level among US states. Even though Illinois was rated only one level lower than California, the interest rates it was forced to pay on its bonds was five times the yield of similar California debt issues. After five unsuccessful attempts by the Governor and the legislature, a pension compromise was passed in December 2013. Illinois estimated that the cuts in its bond ratings over a single year of inaction cost taxpayers $180 million in additional interest costs.2

Analysis

The annual required contribution (ARC) helps to measure the extent to which plan sponsors are meeting their financial obligations. In 2012, employer contributions equaled 80 percent of the required payments.3 The one consistent factor for states with large unfunded liabilities is a history of providing payments at less than the ARC over a sustained period of time. If states with unfunded pension plans were able to fully fund their pension plan ARC for the next decade, the pension gap would be largely closed.

It’s making this journey that can create unmanageable pressures on state budgets. However, recent initiatives show that public leaders with foresight can pursue the path to financial sustainability.

Accenture has identified pragmatic, practical steps that can enable a pensions transformation that delivers lasting effects.

3 Munnell, Alicia H.: Aubry, Jean-Pierre; Hurwitz, Josh and Medenica, Madeline; Center for Retirement Research at Boston College; “The Funding of State and Local Pensions: 2012-2016”; July 2013.

Recommendations

Pilot new plan designs for diverse employees of the future

Forty percent of public employees are set to retire in the next 10 years. Leaders can take advantage of this demographic shift, coupling it with new technologies and business processes to reshape their HR pyramid, thereby lowering long-term personnel and benefit costs.

Pursue innovative investment strategies

As the recession eases, increased returns should help close the pension gap. Some states are using analytics to improve management of their investment portfolio. According to the Accenture North America Pensions Survey, public retirement agency leaders are using analytics to analyze portfolio performance statistics (69 percent), risk in portfolio (69 percent), performance of various portfolio components (66 percent) and comparative portfolio components (62 percent).

Assure that pension payments are prioritized in operating budgets

States sometimes use a binding revenue and expense forecast methodology. This means that all parties agree on revenue and expense targets, and will not vary from them in the legislative process—which is viewed as a financial best practice by credit rating agencies.

Applying this practice to pension payments over a concrete term would provide assurance to bond markets, participants and stakeholders that the state is addressing its long-term liabilities as a priority.

Build administrative savings by using back-office mergers and analytics to sustain benefits

Administrative mergers are helping public sector entities to control administrative costs through centralized administration. The Florida Retirement System (FRS), which covers all state government, county, school district and most municipal employees, has been merged since the 1970s. The system is seamless from an employee point of view as it centrally manages assets and investments, while administering retirement benefits and issuing pension checks centrally.4

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